Private Equity in DOJ’s Line of Fire

Liability Under the False Claims Act

The government can be slow, but it catches up. The DOJ and whistleblowers have recently targeted private equity firms and individuals in False Claims Act cases based on officer and director roles and/or involvement in management. Because the foundations of health care compliance and private equity business goals frequently clash, investors are wise to evaluate their level of involvement and jump on the compliance bus to avoid getting run over.

Health care is a heavily regulated industry and can make for a risky investment if the business in which in a private equity sponsor is investing has significant compliance problems.

A potentially costly risk is civil or criminal charges brought by the government or a private citizen on behalf of the government (a “relator”) under the False Claims Act (the FCA).[1] The FCA imposes liability on individuals and entities that knowingly present or cause to be presented a false claim for payment or fail to promptly return an overpayment it knew or should have known it received.

With triple damages, a range of steep penalties per claim and potential criminal exposure in play, FCA risk is no joke. For the private equity investor, careful pre-acquisition due diligence to detect such potential risk is truly no longer enough if the private equity investor plans to cross the executive, board room or management threshold, which investors often do.

FCA Cases Against PE Investors in 2018

The following two FCA cases were filed against private equity investors in 2018. The cases remain pending with many FCA development followers watching closely.

1. In Florida, two former pharmacy employees filed an FCA suit against a private equity sponsor, the fund’s portfolio pharmacy and two pharmacy executives for their involvement in an alleged kickback scheme.[2] The government intervened, alleging that the fund had a controlling interest in the pharmacy and that two fund representatives were actively involved as pharmacy board members and officers and that they even played an active role in managing the pharmacy. While awaiting a court ruling in this case, the government recently filed a notice pointing the court to yet another case (discussed below) where equity investors are also named and did not get off the hook at the motion to dismiss stage.
2. A whistleblower and the Commonwealth of Massachusetts filed an FCA suit against a mental health care operator, its former CEO and a private equity investor, alleging Medicaid was billed for services provided by unlicensed and unsupervised employees.[3] The complaint alleges that the officers and members of the portfolio company and the private equity investor overlapped, and board members were heavily involved in operational decisions, including contract approval, strategic planning, budgeting and earnings issues. In denying the equity investors’ motion to dismiss — wherein the investor defendants argued there was no explanation of how they directly caused the submission of false claims — the court noted that the FCA does not always require an affirmative act to impose liability. Rather, an investor can be liable where the submission of false claims by another entity was the foreseeable result of a business practice, and in this case the complaint adequately alleged that the private equity fund members and principals formed a majority of the operator’s board, were directly involved in operations and had been advised of the noncompliance issues.

Therefore, depending on one’s tolerance for risk, private equity firms and their representatives are wise to evaluate just how involved they plan to be in the portfolio company. Consider the value versus risk of:

• board or officer roles,
• board control by equity investors and
• involvement in operations or management.

Avoiding such involvement is no guarantee of an investment free of FCA risk, but given the developing case law, such involvement will increase the likelihood of being named in any FCA case filed against the portfolio company. Being named in an FCA suit can be terribly distracting, unproductive and costly, even if there is ultimately no merit to the claim. Therefore, weighing the benefits of hands-on involvement at the executive level, board level and/or management level is important.

If on balance an equity investor decides the value of direct involvement is worth the risk, then compliance and all that a robust compliance program entails must be a priority for that investor. This means ensuring that the portfolio company’s compliance policies are in place, including policy of no retaliation against whistleblowers, compliance trainings are happening, audits are proactively conducted, exclusion checks on employees are run, Anti-kickback and Stark compliance, a compliance hotline is in place and the list goes on.

Of course, effective compliance is not likely to happen if the private equity investor is only focused on the bottom line and is not in lock step with the portfolio company in all manner of compliance. Indeed, these two interests often naturally collide.

[1] 31 U.S.C. § 3729 et seq.

[2] U.S. ex rel. Medrano v. Diabetic Care, Rx, LLC, et al., Case No. 15-cv-62617 (S.D. Fla. 2018).

[3] U.S. ex rel. Martino-Fleming v. South Bay Mental Health Center, Inc., et al., Civil Action No. 15-13065 (D. Mass. 2018).